As an investor, I often need to try to anticipate what will happen in the future. And inflation is therefore very interesting to me. It is becoming clear that inflation may not be transient as policymakers hoped. If inflation persists, it may help bank stocks, which puts them on my radar as I look for additions to my portfolio.
Positive sector results
Recent results from HSBC and Barclays show that banks are recovering from a difficult 2020 – arguably better than other sectors that have been affected by the pandemic. HSBC profits rose 74% in the third quarter. Barclays announced that in the same quarter its pre-tax profits were Â£ 6.9 billion, a record amount for the three-month period.
These results show that banks are doing fairly well, but there may be room for stronger growth in stock prices. The heightened optimism about the economic recovery is an obvious potential catalyst.
Along with the potential for stock price growth, there are the income that banks can provide to consider. In addition to their reasonable yields, the latest AJ Bell The dividend dashboard shows that among the companies in the FTSE 100, three banks, HSBC, Barclays and Lloyds will be among 10 listed groups that will pay investors 80% of FTSE 100 dividends in 2021. It proves that dividend growth is back after the pandemic that resulted in dividend suspensions.
Trip hazards to watch out for
It should be borne in mind that very successful investors such as Terry Smith have generally been reluctant to invest in banks, mainly due to their complexity and use of debt. They also have to hold huge amounts of capital due to the increased regulation introduced after the credit crunch. The prices of bank stocks are also very much linked to the health of the economy. As such, these are not necessarily the highest quality buy and hold investments, especially under tough economic conditions.
Bank stocks on the verge of significant growth?
UK listed banks are primarily huge institutions with proportionately large market capitalizations. As they say, “elephants do not gallop”. So huge growth in the share price of these stocks is, I think, unlikely. What is entirely possible is that a recovering economy, a vibrant housing market and the possibility of small incremental increases in interest rates combine to make bank stocks outperform the broader market. I think it is perfectly possible.
There are of course also smaller banks, which should be more nimble than their larger counterparts. They could, if things go well, see greater growth in stock prices. The examples I can think of are Arbuthnot and Metro Bank. The former has a market cap of just Â£ 133million, while Lloyds’ market cap approaches Â£ 35bn.
I don’t think bank stocks are worth buying alone due to the possibility of a rise in interest rates. Instead, the combination of potentially substantial growth in stock prices and above-average dividend yields is the big draw. I may be particularly tempted to buy Lloyds or one of the smaller, more specialized players.
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Andy Ross owns no shares mentioned. The Motley Fool UK recommended Barclays, HSBC Holdings and Lloyds Banking Group. The opinions expressed on the companies mentioned in this article are those of the author and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. At The Motley Fool, we believe that considering a wide range of ideas makes us better investors.